Profit Margins

In Q2, NIPA’s EBIT margin fell to a new four-year low, over one point below the early 2012 cycle peak.

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Corporate profits are notoriously cyclical, and for decades we’ve sought to temper their swings by using a five-year smoothing of S&P 500 EPS in our valuation work.

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While NIPA profit margins peaked nearly four years ago, median margins across the S&P 1500 (and particularly within the S&P 500) managed to hold up until just the past three quarters. But it now looks as though the long-awaited margin squeeze is finally underway.

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A look at profitability trends at the broad sector level; only Utilities and Telecom Services are experiencing levels below their long-term medians.

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Government accounting on everything ranging from the CPI, to the budget deficit, to even the unemployment rate is constantly assailed as being too rosy. So when a government report occasionally paints a less optimistic picture than the consensus one, we’re inclined to sit up and take notice (especially when we agree with it).

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The S&P 500 record median profit margin of 10.3% is now almost a full percentage point above the last cycle’s peak of 9.4% (second quarter of 2007). Trends across S&P sectors are not as uniform as one might expect, though, with only half of the ten sectors last quarter at profitability levels that exceeded their 2001-2007 expansion highs.

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A good rule of thumb for fundamental forecasters is that projected events almost invariably take much longer than anticipated to occur, but then—once underway—unfold with much greater speed and power than originally expected (think subprime).

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Q4’s margin figure is only one tick below the all-time high of 10.3% set in Q4 2011.

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Earnings growth over the next few years will—in the  best case—be forced down to the rate of top-line growth (nominal GDP).

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We’ve noted before that profit margin gains since the technology boom have been primarily a Large Cap phenomenon.

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The celebrated gains in corporate profitability over the past decade and a half are attributable primarily to proportional declines in “below the line” items like interest expense and corporate taxes.

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Current record high corporate Profit Margins examined in this month’s “Of Special Interest.” Topics include the sustainability of the trend, commodities as profit trackers, margins as a potential forecasting tool and discussion on profits by sector and market cap. 

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An examination of both near term and longer term historical profit margins broken out by sectors is presented in this month’s “Of Special Interest” section.

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In this month’s “Of Special Interest” section, Jim Floyd updates the broad sector profit margins charts. Information Technology now producing 15% margins, the highest levels ever. Energy and Materials sectors still relatively low, but rising commodity prices will support higher margins in 2011.

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Analysts typically focus on demand for products and rarely look at the supply side. Consumer Discretionary companies were rewarded for their pessimistic positioning with better pricing and higher margins. 

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This month’s “Of Special Interest” takes a look at Q4 profit margins across the 10 broad economic sectors. Best looking is Information Technology, while Consumer groups have also seen impressive gains by becoming lean and mean.

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Inflation is peaking and the GS Scores did a great job signaling an exit from the Industrial Metals play. Commodities were hit hard in July.

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With or without Financials, earnings momentum has been gradually deteriorating over the past two years as sales growth slowed and margins have been pressured.

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